Weighing risk against security
With volatility the norm these days, it’s scary to think about risking your hard-earned savings in the stock market. But you don’t want to run out of money in retirement, which is a risk if you park all of your savings in the bank.
When building a conservative investment portfolio, it’s important to take a look at your overall investment plan and your risk profile, says John Corn, CPA, a financial planner with Buckingham Asset Management in St. Louis. “It’s all about creating a plan, balancing risk with the need for security,” he says. “You also need to look at your spending plan and how much income you are going to need every year, and your sources of income, such as Social Security, a pension and your investments.”
Setting up or revisiting your asset allocation is an important part of this process, says Joe Jennings, investment director for PNC Wealth Management in Baltimore. An asset allocation plan divides up your investment assets among different types of investments, such as stocks, bonds, real estate and cash.
Balanced funds own a mix
Balanced mutual funds are a good choice for conservative investors because they provide exposure to stocks and bonds in one fund, says Evan Shorten, a CFP with Paragon Financial Planners in Los Angeles. “Balanced funds with 20 (percent) to 40 percent of their assets in stocks, and the rest in bonds, are going to give you consistent returns with a potential for gain on the upside,” he says.
Even though you may be nervous about investing in stocks, it’s important to have some type of stock component to your portfolio to provide growth over the long term because you don’t want to outlive your assets. “In spite of the short-term volatility, (stocks) have an expected return that is higher than inflation,” says Corn.
Bonds serve as ballast
Bonds play an important role in any conservative investment portfolio tailored for retirees, says Corn. “They should be a risk mitigator,” he says. “It’s not an area where you want volatility or where you want to take risks.” He favors high-quality bonds, such as Treasury bonds or highly rated corporate bonds, either individual bonds or bond funds.
Corn doesn’t recommend high-yield bonds, also known as “junk bonds.” Nor does he like high-yield bond funds because he believes they’re too risky. Shorten, however, likes multi-sector bond funds, which are bond funds that invest in a wide variety of bonds, including high-yield or junk bonds, Treasuries, Treasury Inflation-Protected Securities (also known as TIPS), U.S. dollar-denominated foreign bonds and emerging market bonds. “The managers of multi-sector bond funds can choose between sectors and decide, based on tactical considerations of what’s going on in the markets, what the portfolio will look like,” he says.
Diversify via REITs
Real estate investment trusts, or REITs, are another investing option that provides diversification and generates income, says Shorten. REITs invest in commercial property, such as warehouses, office buildings and shopping centers, and some invest in mortgages.
REITs are required to pay out 90 percent of their income in the form of dividends to their shareholders. Many have dividend yields in the 4 percent to 6 percent range. However, due to some financial problems experienced by REITs during the financial crisis, they are permitted to pay up to 90 percent of those dividends in stock, rather than cash, through the 2011 tax year.
“REITs are a source of income, but they can be very volatile, as we saw during this recent downturn,” says Shorten. “If you invest in a REIT, make sure it’s one that is diversified not jut geographically, but also by the type of commercial property. That’s crucial for diversification, stability and to dampen volatility.”
You can buy shares in individual REITs, which trade on the stock exchanges, or REIT mutual funds, which invest in a number of different REITs. That provides additional diversification.
Consider immediate annuities
If you want a guaranteed income payout, annuities are an option. In exchange for a lump sum or payments over a series of years, you get monthly income until you die. “Annuities are an exceptional way to generate income for a period of time or a lifetime,” says Shorten.
There are many different types of annuities and they come with lots of different features. They can be expensive. It’s a good idea to consult with a trusted financial adviser before you decide if an annuity is right for you.
Dividends offer income, growth potential
PNC Wealth Management’s Jennings likes dividend-paying stocks because “cash flow is important to many investors right now.” They can provide a steady flow of income with potential for growth as well. You can buy individual stocks that pay dividends or mutual funds, or purchase exchange-traded funds that invest in dividend-paying stocks.
The only potential problem with buying individual stocks that pay dividends is that the company paying the dividend could decide to cut the dividend, as BP recently did. In that case, “you want to be very well diversified,” Jennings says, “so if you’re unfortunate enough to experience a dividend cut, it won’t impact you too significantly.” Buying a dividend-oriented mutual fund or exchange-traded fund, instead of individual stocks, helps to diversify a conservative investment portfolio.
Investing isn’t rocket science, but it helps to get a handle on how risky certain assets are — as well as on how tolerant you are of risk. Check out these resources to learn how to design a conservative investment portfolio.